Sunday, March 4, 2012

Oil: Playing Cat And Mouse

Last week the oil price fell 2.8% and closed at $106.77 a barrel, after hiking above $110.55 on Thursday. As in the weeks before the roller coaster was caused by rumors and geopolitical speculation. Thursday the Iranian state-run news station "reported" an explosion which lead to the destruction of a important pipeline in eastern Saudi Arabia, causing a jump of nearly 5% (marketwatch). The hike was soon erased as Saudi Arabian officials responded and called this news "untrue".

On Friday oil fell the most this year as President Barack Obama said a pre-emptive strike on Iran might generate “sympathy” for the Persian Gulf country, easing concern that an attack would take place, wrote Bloomberg (bloomberg).

Why does the price of oil react to this noise? Oil futures are priced by buying and selling on financial markets like stocks. Oil futures are just financial assets, there is not much connection to buying and selling physical (real) oil. Many huge hedge funds and pension funds invest billions into the oil futures. Last Friday Marketwatch reported that "money managers increased their long positions, or bets oil futures would go higher, by 9,232 in the week ended Tuesday, according to data from the Commodity Futures Trading Commission released late Friday. The managers ended the week with 284,800 long positions. They sold nearly 4,000 short positions, or bets prices will go lower, to end the week with 12,768 of such positions" (marketwatch).

For months the oil price has been driven by bets on possible supply disruptions from the Middle East region, as it was in 2008 when it spiked to $147. Many hedge funds set their wagers on a possible worsening of the Iran conflict, meaning that the Middle Eastern country could stop its own oil deliveries or disrupt the oil flow from Saudi Arabia and other neighbors by closing the strategical important Strait of Hormuz. Some might even bet on a war against Iran which could worsen the supply disruption.

Iran, which earns most of its income by selling oil, knows this coherence very well and uses it to play cat and mouse with the West and oil customers. While Teheran seems to be capable of developing a nuclear bomb, the Iranian government is also able to play the oil market by influencing expectations. Teheran does that for instance by reporting about progress with their nuclear program, which usually causes rising oil prices, with saber rattling like threats about possible military actions and - as on Thursday - spreading rumors.

These games cannot go on indefinitely, no games does. I guess further rises of the oil price need sharper threats, including real military action. In the moment the oil-rumor-games looks overexcited, as the market response to the calming words of the U.S. President shows.

One bit of news is very interesting in this context. Saturday Bloomberg reported, that the number of Iranian tankers used to store oil at sea slid to a two-year low (bloomberg). "Four very large crude carriers, each able to hold 2 million barrels, are in use to store Iranian oil, down from 16 at the end of last year", wrote Bloomberg. I take this as a sign that Iran might already speculate on a falling price of oil. In this case it would be rational to sell oil and to reduce the stored volume of oil to avoid losses.